Decentralized Finance or DeFi has emerged as a formidable revolution in the conventional concepts related to finance. With the power of blockchain technology, DeFi solutions could provide new approaches for accessing and using financial services. Crypto lending has become one of the formidable trends in the DeFi landscape, especially after the COVID pandemic in 2020. The new trend in DeFi is one of the many new ways to grow your crypto assets.
The rising popularity of cryptocurrencies alongside their mainstream adoption all over the world has opened up the crypto world to a broader audience. At the same time, crypto-assets present many interesting opportunities for expanding their savings and boosting their investments. As compared to holding your crypto assets, you can lend them for earning passive income on them. The following discussion would help you find out the answer to “what is crypto lending?” and how it works.
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Traditional Lending Mechanisms
Before you try to find a crypto lending calculator, it is important to know the foundations of cryptocurrency lending. The best way to understand crypto-backed lending is to take a look at the traditional lending mechanisms. People generally take loans when they are short of cash and approach a bank or a finance company for loans. The borrowers must repay the loan to the bank or the company with a specified amount of interest.
The bank or company could make money through the interest earned on the loans they provide to borrowers. In this case, you might wonder where the bank gets the money to lend to its borrowers. The answer is evident in the money deposited by other customers of the bank and in other financial instruments. So, the bank or the company is just working as a middleman between the actual lenders and borrowers.
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What is Crypto Lending?
Imagine a scenario where you don’t have any middleman between the borrower and the lender. Crypto lending provides an alternative approach for investing your crypto assets, where you can lend cryptocurrencies or fiat to borrowers. You can earn interest on the cryptocurrency you loan to a borrower without any intermediaries. You can find various solutions which can help you give out a loan with your crypto assets and earn interest directly.
Working of Crypto-backed Lending
The next important aspect in an introduction to crypto lending would obviously draw attention to its working. Crypto-backed lending processes generally leverage digital currency in the form of collateral, just like securities-based loans. The primary principle in crypto-backed lending is almost similar to that of an auto loan or a mortgage loan. You can pledge crypto assets to obtain a loan at specified crypto lending rates and pay back the loan over a specific period of time. The most common places to get such loans include crypto exchanges or cryptocurrency lending platforms.
Borrowers can retain the ownership of the crypto they have used as collateral, albeit while losing some rights. For example, borrowers could not use the crypto assets for transactions or trade them. In addition, a substantial drop in the value of assets placed as collateral would imply that borrowers would have to pay more than the borrowed amount in event of a default on a loan.
You can clearly notice that there are two distinct parties in crypto lending transactions, the borrower and the lender. The borrower takes on the responsibility for depositing crypto assets in the form of collateral for securing the lender’s investment. The lender would receive the interest from borrowers in return for the loan and have the assurance of the collateral. If the borrower fails to repay the loan, the collateral can compensate the lender.
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Steps in Crypto Lending
Diving further into the steps involved in crypto lending from the perspective of lenders and borrowers could provide a better impression of the DeFi solution. Irrespective of the platform used for crypto-backed lending, the steps are almost the same in the view of borrowers and lenders.
Borrowers have to go through the following steps.
- Register on the platform which offers crypto-backed loans and showcases the desired sum.
- The cryptocurrency lending platform would leverage crypto lending rates for calculating the amount of crypto required as collateral.
- Borrowers have to deposit the estimated collateral on the lending platform and apply for the loan.
- The platform verifies the borrower’s collateral and deposits funds in the account of the borrower upon the approval of their loan.
On the other hand, the process of crypto lending is different from the perspective of lenders. Here are the steps for you if you are a lender of crypto.
- Lenders must select a specific interest rate.
- The lender offers crypto assets to borrowers and receives bonds in return. The bonds prove the fact that you have lent crypto to the borrower.
- Lenders would receive additional bonds as interest.
- You can recover your money after the agreed-upon time by sending back all the bonds. Lenders could utilize smart contracts for sending back the bonds and receiving crypto in exchange for the bonds.
Reasons to Lend Crypto
Now that you know about crypto lending rates and how crypto-backed loans work, it is reasonable to wonder why you should choose crypto loans. Here are some promising reasons for which you should lend crypto to other people.
The clearly evident benefit for lenders in crypto-backed lending is the opportunity to earn interest directly. Lenders are more likely to get more crypto in exchange for the loaned amount. As a result, you can make better profits without investing any considerable effort. Furthermore, the crypto lending rates are considerably better than the ones for conventional savings accounts.
The most basic advantage of crypto lending is the flexibility to lend any type of crypto you want. Crypto owners can use the opportunity for lending stablecoins to expand their assets without any volatility risks. Basically, you would have a clear impression of how much you will get in return for your crypto assets.
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Best Practices for Crypto Lending
Even if there are many opportunities associated with crypto asset lending, it is also reasonable to consider certain implications. For example, you need to find answers to doubts such as “How safe is crypto lending?” before you venture out. Here are some important pointers which can help you with crypto-asset lending.
One of the foremost factors which can help you with crypto-asset lending more than a crypto lending calculator is research. Investing some time in doing your own research could help you identify suitable platforms for crypto loans. The best choice in such cases would refer to platforms or smart contracts with well-audited security and a favorable track record.
The next critical factor among best practices for crypto lending refers to a detailed understanding of the loan’s terms. It is important to verify the time within which you can get back your crypto and the amount of interest. In addition, you should also check for any contingency plans which can help you in case anything goes wrong. For example, the lending platform should have provisions for taking collateral from borrowers or insurance for lenders.
Understand the Implications
You should also take note of the implications such as “How safe is crypto lending?” and the consequences of having your crypto locked in the lending platforms. Furthermore, the best security measures in the world have not been able to restrict hacks in the crypto world. So, you should take some time to think over these things before investing in crypto loan platforms.
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Getting Started with Crypto Lending
The massive growth in attention on ‘what is crypto lending?’ has definitely encouraged many investors to participate in the idea. Here are some favorable options you can try out for getting started with crypto-based lending.
You can rely on crypto exchanges and custodial platforms offering lending services, which are basically centralized services. The exchanges and platforms serve as middlemen, and you have to provide your private information for making accounts on these platforms.
Another prolific approach for getting started with crypto lending refers to decentralized finance or DeFi protocols. The DeFi protocols remove the need for any middleman and use smart contracts for the management of loans. In addition, the smart contract would also automate transactions in accordance with the fulfillment of specific predefined conditions. Lenders do not have any possession over the crypto which they have lent as the assets would go into a smart contract. The well-audited smart contracts in popular DeFi protocols provide the assurance of security from any potential vulnerabilities.
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The concept of lending your crypto to earn interest on it is definitely a favorable proposition. As a matter of fact, lending crypto could easily open new avenues for mainstream adoption of cryptocurrencies. In the longer run, crypto lending can evolve into one of the most prolific aspects of the transformation of financial services.
Lending crypto assets offers a flexible approach for borrowers to obtain cryptocurrency or fiat money in return for their crypto assets. However, crypto-based lending is still limited to the developmental stages and might take some more time to gain prominence. Start discovering more about crypto-backed lending and its implications right now!
*Disclaimer: The article should not be taken as, and is not intended to provide any investment advice. Claims made in this article do not constitute investment advice and should not be taken as such. 101 Blockchains shall not be responsible for any loss sustained by any person who relies on this article. Do your own research!